A short covered call is an options strategy that involves both stock and an options contract. The trader buys stock, and then sells a call contract, and then waits for the options contract to be exercised or to expire. If the options contract is exercised (at any time for US options, and at expiration for European options) the trader will sell the stock at the strike price, and if the options contract is not exercised, the trader will keep the stock. In a short covered call, the call can be an out of the money call, which allows for profit to be made on both the options contract and the stock, or an in the money call, which provides more protection if the price moves down (against the trade).
Making a Short Covered Call
- Purchase stock
- Sell a single call contract
- Wait for the call to be exercised or to expire to realize the profit
Risk and Reward
As shown on the risk / reward chart (view the full size chart), the risk of a short covered call is high, as there is no protection if the stock price moves significantly downward (against the stock trade). The risk of a short covered call is calculated as :
Maximum Risk = Unlimited
Loss = Purchase Price of Stock - Price of Stock - Premium Received
The reward of a short covered call is limited to the premium received for the call (for an at the money, or in the money call), or to the difference between the stock and strike prices plus the premium received for the call (for an out of the money call). The profit of a short covered call is calculated as :
Maximum Profit = Limited
Profit = Strike Price - Purchase Price of Stock + Premium Received
